TMFDeej (99.32)

Is the dollar really doomed?

11

Many people have been preaching about the eminent demise of the U.S. dollar lately. It's not difficult to see why one would think that the dollar is doomed. The United States has its printing presses running at full speed while the government is spending money like water and running up a record budget deficit.

The White House has forecast that the budget deficit will hit $1.84 trillion this fiscal year, or approximately 12.9% percent of GDP. I actually think that this estimate is on the low side and that we might end up being $2 trillion in the red by the end of the year and that it will be a much larger percentage of GDP (which I suspect will be lower than the optimistic folks in the White House are purporting to believe).

The United States is relying upon the kindness of strangers to finance this massive budget deficit. Foreign countries, such as China and Japan which currently hold 23% of America's federal debt, will have to continue to purchase our bonds at the same pace that they have over the past several years, or even more rapidly for us to continue spending like we are.

The question is whether they will get sick of buying up all of our Treasuries and whether they will even be able to with economic problems of their own as a result of their exports falling at a record pace.

Our "friends" in China and Japan have even been voicing their concerns about the U.S. dollar lately.

- Masaharu Nakagawa, the finance chief of the Democratic Party of Japan, said that he wants the United States to sell debt that's denominated in Yen.

- Several months ago Luo Ping, head of China's banking commission was quoted as saying "We hate you guys. Once you start issuing $1 trillion-$2 trillion, we know the dollar is going to depreciate."

- Even China's Premier Wen Jiabao said not that long ago that he is concerned about whether the "massive amount of capital" that his country has lent to the United States is safe.

So, the U.S. dollar is doomed right?

Not so fast my friends as the College GameDay's Lee Corso would say.

First of all, as the old saying goes, "In the land of the blind, the one-eyed man is king." The exporting countries that relied upon the U.S. consumer for years are now starting to find out what things are like when the demand for all of their trinkets from the great consumers in the United States drops like a rock. According to recently published statistics, Japan's industrial output has dropped by 34% and Chinese exports are off 23%. As bad as things are in the United States right now, they're even worse in places like Japan and much of Europe.

Currencies are all relative, for a currency to fall off of a cliff it has to drop in value in relation to something else. As long as the economies of other countries with major currencies, like the U.K., the European Union (I realize that this is not one country), Japan, and China are in rough shape their currencies will be under tremendous pressure as well.

Furthermore, the Chinese and Japanese currently hold a huge amount of U.S. debt. If they were to stop buying our paper cold turkey, the value of their holdings would likely collapse. They can rattle their sabers all they want, but if they were to make a major move they could hurt themselves as well.

Check out the following quotes from an excellent article on this subject by Ambrose Evans-Pritchard"

Ray Maurer, from Qatar's QNB Capital, said China may be too busy closing factories it should never have built to challenge US primacy over coming years.

"China is not going to be a juggernaut until it creates a viable economy based on home consumption. It's just a tiger, living a myth," he said.

and

Lombard's Charles Dumas says the "super-savers" (China, Japan, Germany) have warped their own economies by relying on exports and, therefore, on perpetual debt build-up by the West.

"Their currencies are due to decline against the dollar as weak US recovery throws a few scraps from its table, over which the world's exporters will have to scrabble, cutting their prices and currencies in the process. The US is not, and is not about to become, Argentina or Zimbabwe," he said.

Having said all of this, I personally believe that the U.S. dollar will definitely lose value over time. I am of the opinion that its decline will be more gradual than many others currently believe. No one knows for certain what will happen. As a result, I'm playing both sides of this game, inflation and deflation. I have picked up stakes in a number of high quality companies in sectors like consumer staples as well as a large number of high-yielding corporate bonds that should be fine even in a deflationary environment.

At the other end of the spectrum, I own stock in inflation hedges, specifically commodities like oil and natural gas. Approximately 10% of my portfolio is in oil-related common stock and another portion is in preferred stock / bonds of natural gas companies.

The inflation versus deflation debate is a very interesting one. As I have said in the past to me deflation is definitely the more immediate risk...unless the value of the dollar falls off of a cliff.

As bad as things are in the United States right now, they're even worse in places like Japan and much of Europe.

Why should that be so?

As long as the economies of other countries with major currencies, like the U.K., the European Union (I realize that this is not one country), Japan, and China are in rough shape their currencies will be under tremendous pressure as well.

I am not sure I would consider the CNY a "major currency" and it is somewhat surprising to hear someone voice the concern that it is "overvalued" vs. the USD. I think you can safely call that an "unconventional" opinion (nothing wrong with that and actually refreshing to see you leave the mainstream path for once).

The argument that the dollar cannot experience a crisis of confidence because major dollar holders will not take actions that would spark such a crisis is unfounded. The direction of the dollar has been laid in stone by the masive scale of dollar-denominated derivatives and the trillions pledged to prevent the deleveraging of those debts, pure and simple. The actions of major holders can only impact the timing of the greenback's slide, but not the direction.

A crisis does not have to hit overnight to be called a crisis... in some ways a more gradual deterioration of value is even more insidious. Best-case scenario, we are facing a gradual onset of stagflation as quantitative easing persists in an orderly fashion and foreign creditors merely slow their acquisitions of Treasuries rather than unloading them.

In one worst-case scenario, our creditors join economic forces and compose a new global currency regime that either revalues the USD to some fiat basket or introduces a modified version of the gold certificate ratio.

Either way, the dollar's direction is downward, and I challenge anyone to prove otherwise.

I've presented my proof for that statement countless times throughout my blog and published articles. Under the circumstances, the burden of proof clearly would lie with a dollar bull. Are there even any dollar bulls out there, or are you just wasting my time? :P

Sure, I'm referring to the >$1 quadrillion global market for derivatives that lies at the epicenter of this financial crisis. The frozen market for these excessively leveraged, dollar-denominated casino bets is the black hole that the trillions of USD in interventions to date have been tossed into as a stopgap measure. The effort is futile, and the Evans-Pritchard article I referred to in my blog post that was pulled would have proven that the administration KNOWS it's futile.

The combined impact of the unavoidable unwinding of that derivatives market, plus the trillions tossed at the banks to maintain a semblance of liquidity, plus the onset of quantitative easing, plus the already significantly reduced global appetite for USD debt, plus the outlook for severely reduced tax revenue, plus the specter of $1+ trillion budget deficits for years to come, plus the certainty of further bailouts as the stress test parameters are revealed to have been a terrible joke, plus global efforts to establish a new reserve currency regime ........ all combine as clear-cut proof that the USD is in crisis.

Not to mention dozens upon dozens of blog posts with supporting fundamental as well as technical evidence.

I repeat my question, are there really Fools out there who think the dollar will exhibit long-term strength, or are people just yanking my chain? This is elementary stuff, guys... with all due respect, if you haven't figured out that the dollar is heading lower by now, I'm not sure what to say to clue you in.

That is not what I'm referrring to by technicals... I certainly would not advocate that trade... the dollar's slide is not a trend you want to stand in the way of... regardless of whether it occurs quickly or gradually.

In fact, Fools, I do not advocate use of any such ETN that is based upon the very same derivatives that lie at the epicenter. If these ultra ETFs begin to fail because their underlying derivatives have no functioning market, Fools could be in for quite a shock.

Anyone wondering why the USO has done such a horrendous job tracking the movements in crude??

One brings up the idea of Brazil and China holding discussions on conducting trade in Yuan and Reais instead of the dollar, which seems to be only talks at this point. That same article though says Brazil and Argentina are starting to trade in local currencies instead of the dollar though, which shows countries are looking for ways around using the dollar as the world's reserve currency.

The other article talks about loans China has made to Brazil, Russia, and Venezuela in exchange for oil. Commodities are still pretty cheap comparitively speaking to a few years ago so if China can divest some of it's large dollar holdings to aquire oil or whatever at a good price it helps satisfy it's need for raw materials and hedges against a falling dollar at the same time.

I have made those predictions elsewhere, including in published articles, and offered proof therewith.

So no proof, just opinions backed up by the same opinion in a different article, including the ever popular "the dollar will fall, you must be in gold" line that we've been listening to since we went off the gold standard 40 years ago.

I'm not trying to pick on you Sinch, but I have grown tired of all the people on this site who have lately been saying "my opinion of what will happen will with absolute certainty happen and if you don't agree then you don't know what you're talking about." Really, let's call opinions what they are (something I will give you credit for normally doing). They're not proof, they're not fact, they're not inevitable, which is the point Deej is making with this post.

Gold, people, gold! If you want to tailor your portfolio to match expectations for a long-term dollar decline, gold and silver must be given proper consideration. Gold IS a currency ... it is, in fact, the currency of last resort, and the only currency that is unencumbered. Those that classify gold as a commodity are mistaken, with all due respect. Gold and silver must be considered differently, even though that share many characteristics of commodities. These characteristics could prove an important component of their safe haven status.

Absolutely not, this is not merely opinion. This is the defensible, logical conclusion of a preponderance of the edivence. Shared by many, it is also, in that sense, theory. I will not call it fact, but I will call it a compelling collective argument if you take the time to review the evidence I offer.

Lombard's Charles Dumas says the "super-savers" (China, Japan, Germany) have warped their own economies by relying on exports and, therefore, on perpetual debt build-up by the West.

"Their currencies are due to decline against the dollar as weak US recovery throws a few scraps from its table, over which the world's exporters will have to scrabble, cutting their prices and currencies in the process.

For Germany the U.S. are not really that important as to trade:

In 2008 Germany imported from the U.S. goods with a value of ca. 46B EUR and exported to the U.S. goods with a value of ca. 71B EUR.

In the same year Germany imported from the Netherlands goods with a value of ca. 77B EUR and exported to the Netherlands goods with a value of ca. 66B EUR.

I've read a number of articles that come to essentially the following conclusion: "Don't buy the banks because Uncle Sam is in there now and he is a fickle manager. Government policy can turn on a dime and there's no way to know how that policy will effect your stock." I totally agree.

Now we have some people who are willing to bet on the long term demise of the dollar. Doesn't essentailly the same argument apply here? I can easily imagine a scenario where inflation starts to get bad and popular support arises for someone like Ron Paul, who promptly ties the dollar to gold, which could screw a lot of people who have invested for the demise of the dollar.

I agree, with our current policies the decline of the dollar is certainly possible (even probable) in the long (even medium) term, but aren't you betting, in a sense, on the consistancy of government policy?

This seems like an awfully dangerous game and one that I'm certainly not willing to play (okay, so in a way, we're ALL playing . . .). I think Deej is right to hedge, because there's just no way to know what's going to happen here. To the extent that we can, it's probably best to isolate one's assets from the wheel of politics as much as possible, and make bets both ways (preferably on companies that are actually selling something useful, be it gold or toilet paper or cell phone service).

The United States is actually managing monetary policy fairly well right now. Yeah, the US is printing out money, but we're in a deflationary spiral. We absolutely should be printing out more money because basic economics tells us the problem is undersupply.

The fact that China and Japan are unhappy with these moves should not be surprising. Just as a commodity producer would rather supplies stay suppressed because it jacks up their profits, China and Japan want the dollar to continue to appreciate in value so they make more money by holding government bonds.

I'm not worried about Federal monetary policy all that much to tell the truth. What am I worried about is wasteful spending practices. It's not that the government is spending money --- it's that it's basically been throwing it mindlessly at a bunch of powerful interests with any concern for the American taxpayers. If we had created a true infrastructure package (rather than the alleged "infrastructure"/stimulus package) --- that would've been fine. Throwing money down a black hole is never good.

To be honest, Deej, I've find myself in disagreement with your investing strategies for the past several months. Which is alright --- we all have our own strategies, but I'll tell you why I disagree:

You were in favor of buying bonds at the stock market bottoms, in a period where equities were supremely undervalued. The belief was that the bonds were safer. I disagreed with that assessment because many equities were already priced near liquidation values. At that point, the bonds aren't really any safer than the equities despite conventional wisdom suggesting otherwise. When equities are priced near liquidation levels, you're going to earn much higher returns which is going to offset the higher risk, so long as you diversify prudently.

Now, you've split between bonds and a few consumer staple stocks and oil/natural gas.

Well, oil has already had a bit of a run at this point --- probably will still go up long-term, so I guess I can't criticize it too much. I think it should hover around $70 - $80/barrel sometime over the next decade, but given the huge inventory levels right now, I could certainly see it retreating back to $45/barrel in the short-run. Natural gas --- guess I'm not as bullish on it as everyone else. I think prices will stay fairly low.

However, I would be more interested in oil and natural gas service firms plus refineries --- companies like Dawson Geophysical (DWSN), Valero (VLO), and Calumet (CLMT). They've been unfairly beaten down at this point and probably offer better returns than oil and natural gas funds/ETFs/commodities.

With the Dow at 8500, I don't necessarily think the bonds are a bad bet any more. Probably can make more money in the stock market, but bonds are safer and I agree with your premise that most American companies aren't going bankrupt. If the Dow climbs up to the 9500 - 10000 level, I think corporate bonds become even more attractive.

Consumer staples, on the other hand, tend to be fairly valued right now and often suffer during recovery as investors look to move into more lucrative stocks. Instead of consumer staples, I would be looking for beaten-down companies that provide some safety in sectors that should benefit in the future. On that note, I like railroads. CSX (CSX), Norfolk Southern (NSC), and Burlington Northern Santa Fe (BNI) all pay substantial dividends, but they are priced for a continual recession/depression right now.

Anyways, just my thoughts. Of course you're free to disagree with me. People think I'm insane because I've been buying into REITs that I feel have liquidation values much greater than the current stock prices like Winthrop (FUR), Lexington (LXP), and Brandywine (BDN) --- so I admit I'm a bit of a contrarian.

Thanks for sharing your thoughts Hun. While I talk about the moves that I have made, I have a fairly diversified portfolio that has benefitted from the recent rally in the stock market...just not as much as everyone who bought the trashiest stocks in the worst sectors like consumer discretionary etc... which have led this rally.

I very much disagree with your assessment of my bond investments. Assuming that interest rates don't explode, I have locked in interest rates of near 10% on reasonably high quality paper which sits at the top of the capital ladder that will pay me for the next several years. I'm trying to be an investor here, not a trader. If the current rally in the market retraces, I will still have my fat yields. The bonds that I boughthad the largest spread over equivalent Treasuries that we will probably see in our lifetimes.

I don't know anything about the specific REITs that you mentioned, but many of the companies in this sector are nothing more than glorified ponzi schemes that are sitting on property that's worth nothing even close to what they claim it is.

"You have to understand that tying the dollar for gold does not constitute a way out for the dollar. The valuation of gold that would be required would in fact equal the demise of the dollar."

Okay, bad example. But suppose we suddenly get someone in office who is determined to strenghen the dollar, and begins immediately with high interest rates, quantitative tightening, etc. Maybe some crazy stuff that no one has thought of yet.

Are you saying 1.) That this won't happen (someone like this will never make it into office) or 2.) There is absolutely no policy that will stop the dollar's decline or 3.) Something I've missed?

Your #2 applies... the path for the dollar has been etched in stone. Quantitative easing is not a choice at this stage, but the only way to absorb the revenue shortfall relative to existing spending obligations given the reduced appetite abroad for U.S. debt.